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Information > Financial Terms > This page Maturity Distribution In
high-grade bond holdings, the diversification of maturities as to short-term,
intermediate-term, and long-term, aiming at a straddle on the problem
of open market price depreciation versus normally higher yields on longer-term
maturities. The market prices
of high-grade bonds respond inversely to fluctuations in money rates and
yields on high-grade paper and obligations, i.e., when interest rates,
open market money rates, and yields on such obligations rise, their
open market prices decline in order to afford higher yields, because
the rate of interest payments that such bonds pay is fixed as of the time
of their issuance. Moreover,
because normally long-term maturities yield more than short-term maturities,
a given magnitude of change in money rates and yields will have more impact
on long-term high-grade bonds, and hence on their open market prices,
than on short-term maturities. The
latter, therefore, are more stable in open market prices, normally, than
long-term maturities; in addition, they can be more easily held to the
final short-term maturity, allowing one to bypass the problem of open
market price depreciation by pre-planned holding to final maturity. Thus
long-term maturities normally yield more but are more vulnerable to open
market depreciation, should money rates and yields on high-grade obligations
rise in the intervening years before final maturity and should they have
to be sold instead of held to final maturity.
Of course, if long-term high-grade bonds can be held readily to
final maturity, the problem of open market price depreciation in the intervening
years will be bypassed, since there should be no question of payment in
full of high-grade obligations at final maturity, and since institutional
investors such as commercial banks (see COMPTROLLER'S REGULATION)
and life insurance companies may carry such high-grade bonds at book values
(less amortization of premium in cost if any), thus ignoring open market
depreciation if any. A
completely short-term maturity concentration (e.g., maturities of under
one year) will normally entail lower yields and hence lower income from
investments, a particular problem when investments constitute the bulk
of earning assets, but it provides highest protection against open market
depreciation in the event of sale before maturity (so-called money risk
or interest risk rate). On
the other hand a completely long-term maturity concentration will provide
higher yields and hence income from investments, but greatest exposure
to risk of open market depreciation in the event of sale before final
maturity. Spacing maturities
in a diversified manner among shorts, intermediates, and longs, therefore,
provides the following advantages:
(1) overall yields on the portfolio are improved, (2) in the course
of time, the maturity of the shorts periodically provides funds for reinvestment
in longs at prevailing yields, (3) the portfolio will always have a layer
of shorts as a secondary reserve which, in the event of required sale,
will have least risk of open market depreciation. Execution
of a program of maturity distribution requires the availability of desired
maturities in the market. Such
diversification of maturities is available particularly in |